Financial Tightening and Its Real-World Consequences: Lessons from Regional Banks in Recent Portfolio Adjustments

The collapse of two sizable, regional U.S. banks – and the decisive and unprecedented response by the FDIC and Treasury Department – showcases the real-world, practical consequences of rapid financial tightening. As a result, we are enhancing the overall quality and resilience of our portfolios: cutting net exposure to stocks and credit, amidst unusually elevated uncertainty.

According to Haver Analytics, BlackRock, and the Federal Reserve Board: as of February 28th, regional banks were responsible for nearly 50% of American business and consumer lending.

Source: Haver Analytics, BlackRock, and Federal Reserve Board (February 2023)

These borrowers now face the likelihood of heightened cost of capital, further deposit leakage, and an increased need to over-collateralize. Such cracks across the sector may instigate brake-taps in lending, and less lending could represent real financial tightening.

Source: Bloomberg, US Loan Officer Survey (March 2023)

From our portfolio-centric perspective: regardless of whether a formal recession materializes, these banking-related developments – along with recent earnings and economic data – suggest that the potential downside risks for stocks have become more pronounced.

Source: Wall Street Journal (March 2023)

This situation has greater potential to adversely impact the economy than the slow(er) drip of the Fed’s ongoing, target rate increases – which should, in our view, persuade the Fed to soften the tone (and implied actions) of its recent, hawkish messaging.
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We feel that the market does not yet properly reflect the risks associated with contracting, bank lending conditions – and their ramifications for the broader economy. Thus, we are repositioning portfolios, as follows: